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The Actuary The magazine of the Institute & Faculty of Actuaries

New PPF levy structure will benefit schemes most at risk

Speaking at the International Actuarial Association Pension, Benefits and Social Security Section Colloquium in Edinburgh, Adam Butt of the Australian National University presented new research focussing on the UK guarantee (or lifeboat) fund and how reform of the levy structure may improve employee benefit security.

"The movement to a new Pension Protection Fund levy structure, incorporating investment risk as a factor influencing the levy paid by schemes, reduces the optimal allocation to equity investment by as much as 16% compared with the current PPF levy structure," Mr Butt said.

"This is because the current levy structure encourages investment in equities in an attempt to increase funding levels, the key factor upon which the risk-based levy is determined, and hence reduce the levy paid. The new levy structure links the risk-based levy to the level of investment risk in the scheme, as well as the funding level, encouraging a lower level of equity investment.

"We have calculated that the result of this reduction to optimal equity allocation is estimated to be an up to 22% reduction in the size of potential scheme deficits. The size of the reduction in optimal equity investment and associated reduction in potential scheme deficits is largest for employer-sponsors deemed to be most "at-risk" of default - meaning that members of these schemes that are most "at-risk" should benefit the most from the new levy structure through reduced risk in their schemes."

Speaking at the same event, Denis Plouffe of Canadian firm GBC Global Benefit Consulting discussed the challenges faced by other countries' major guarantee funds and said that a careful legislative approach was required to achieve improved benefit security as part of a sustainable pension system.

"Employees perceive pensions as 'deferred wages'", he said. "Guarantee funds already exist in a few countries with a developed defined benefit pension system to protect members of pension schemes against market failure, thus protecting these 'deferred wages'.

"In addition, there is an argument to make guarantee funds compulsory in countries where pension schemes are not funded (eg. book reserve system) to avoid a "double blow" to schemes' members when a company enters into bankruptcy. In Germany, this form of insurance is available to members of book reserved schemes.

"Current guarantee funds have their own limitations, though. Firstly, guarantee funds do not fully cover systemic risk as it was observed during the global financial crisis. In Canada, following the failure of Nortel, a variety of proposals have been suggested to improve post-retirement benefit security including an expansion of the current guarantee fund, pension reforms to improve plan funding and broader changes to the Federal Bankruptcy and Insolvency Act.

"The challenge is to improve benefit security while assuring the long-term sustainability of the pensions system. Better coordination between Federal Bankruptcy and Insolvency Acts and Provincial Pension Acts is necessary to achieve the right balance of policies."